Question

1.Find an article in a recent newspaper or magazine that illustrates market failure

2. Identify the type of market failure. Is it a problem of negative externalities, positive externalities, public goods, or common resources?

3. Explain how government action can improve economic efficiency.

4. Graph the market failure and explain the problem. Then show how government action will change the situation.

Answer 1

Market failure occurs when price mechanisms fail to allocate scarce resources efficiently which leads to net social welfare lost.

There are various types of market failure, such as due to negative externality, positive externality, imperfect information, in case of public goods, or due to the presence of monopoly in the economy.

But it is mainly considered to be a problem when it leads to negative externality due to pollution etc.

Government imposes tax on the firms producing negative externality to reduce the production of these products. For example the government will impose environment pollution tax on coal - fired thermal plant which will lead to fall in pollution levels.

Similarly government provides subsidies to the firm producing a positive externality to increase production of the goods considered beneficial to the society.

Price Ideal equilibrium, reflecting social costs Social Cost Private Cost Actual equilibrium in an unfettered market Demand Qs Qp Quantity